Globalization, automation,
decimation of trade unions may have won the class war in favour of capital in
the West, but the countries are still democratic and the masses have to be kept
in good humour

A boyishly handsome spectre is
haunting economics, the spectre of Thomas Piketty. Inequality has suddenly
assumed centre stage in economic discussion. The International Monetary Fund
(IMF) and the Organisation for Economic Co-operation and Development (OECD), a
club of mostly rich nations, have been talking about it.

Even the Pope has chimed in. He
recently set the cat among the Catholic Church’s conservative pigeons by
tweeting, “Inequality is the root of social evil.” But the main reason for the
newfound concern for inequality is a tome by French economist Piketty,
evocatively titled Capital in the Twenty-First Century, that has amazingly
topped the charts at Amazon.com.

What’s so special about Piketty’s
book? Baldly stated, it debunks our fond belief that a rising tide in the
economy will necessarily lift all boats. Piketty writes, “If we consider the
total growth of the US economy in
the 30 years prior to the crisis, that is, from 1977 to 2007, we find that the
richest 10% appropriated three-quarters of the growth. The richest 1% alone
absorbed nearly 60% of the total increase of US national
income in this period. Hence, for the bottom 90%, the rate of income growth was
less than 0.5% per year.”

The Kuznets curve, which said that a
period of rising inequality as growth took off would ultimately be followed by
lower inequality, is a fairy tale. Piketty’s computations lead him to believe
that rising inequality would result in capital’s share of global income rising
to the level it was at in the eighteenth and nineteenth centuries. Labour’s
share, of course, would go down correspondingly.

All right, so inequality is
increasing. But that story is hardly new. The International Labour Organization
(ILO) has been complaining about the declining share of wages in national income
for years. The United Nations Development Programme (UNDP) has been saying the
same thing and numerous academic studies have come to the same conclusion. The
Asian Development Bank (ADB) has chronicled the increase in inequality in
Asia. We know globalization has resulted in
pockets of the First World in the Third and of the Third
World in the First.

The bigger question is: won’t higher
growth offset some of the concerns stemming from rising inequality?

Yes, rapid growth can buy off
disaffection with increasing inequality or even with lack of freedom, a point
well understood by the Chinese ruling class. But Piketty points out that the
rate of growth of global output has been slowing, from 4% between 1950 and 1990
to below 3.5% between 1990 and 2012. He forecasts world growth to taper to 3%
between 2030 and 2050, and then to 1.5% in the second half of the century.

He assumes that the emerging markets
will continue the convergence process with developed countries and there would
also be significant technical progress improving productivity. He bases his
gloomy prognostications on two factors: 1) slower population growth and 2)
slower income growth in developing countries as they increasingly catch up with
the developed ones.

Piketty marshals an impressive
amount of data, over several centuries, to arrive at his conclusions. What
consequences flow from his predictions?

First, it’s likely that high levels
of inequality lead to lower growth. In a recent IMF staff discussion note titled
Redistribution, Inequality and Growth, the authors say it would “be a mistake to
focus on growth and let inequality take care of itself, not only because
inequality may be ethically undesirable but also because the resulting growth
may be low and unsustainable”.

Marriner Eccles, chairman of the US
Federal Reserve under Franklin D. Roosevelt, expressed succinctly what happened
when purchasing power became too lopsided in the run-up to the Great Depression:
“By taking purchasing power out of the hands of mass consumers, the savers
denied to themselves the kind of effective demand for their products that would
justify a reinvestment of their capital accumulations in new plants. In
consequence, as in a poker game where the chips were concentrated in fewer and
fewer hands, the other fellows could stay in the game only by borrowing. When
their credit ran out, the game stopped.” That bit of history sounds familiar,
having repeated itself in the latest financial crisis.

High inequality, therefore, erodes
effective demand, slowing growth. But while inequality may go back to the levels
seen during the nineteenth century, society and social attitudes will not.
Globalization, automation and the decimation of the trade unions may have won
the class war in favour of capital in the West, but the countries are still
democratic and, unlike in the nineteenth century, the masses have to be kept in
good humour. Circuses sometimes do the trick, but often bread and other goodies
are also needed.

The purchasing power of the masses has,
therefore, at different periods, been propped up by fiscal transfers on the one
hand and lending binges on the other. Sub-prime mortgages are a prime example of
the latter. Governments caught between the pincers of footloose capital and
democracy have opted to go in for borrowing, either public or private, to
support effective demand and growth. At the same time, inequality has resulted
in more financial savings by the rich, which has been deployed around the world
in a search for yield. The much-talked about financialization of the worldeconomy is the result. What is quantitative easing but a gambit by central banks
to aim for higher asset prices to stoke the wealth effect, which, in turn, will
lead to more demand?

The upshot of all this is a global casino
economy, where capital accumulation is firmly tied to credit bubbles and waves
of speculation, leading to spectacular and frequent booms and busts. Manas
Chakravarty looks at trends and issues in the financial markets.